In Re: Portnoy[1] — a 1996 Bankruptcy case – was the first in a series of decisions with a foreign asset protection trust. As with most foreign trust cases, the fact pattern alludes to several areas of law – asset protection, bankruptcy, conflict of laws and trusts. Here are the relevant events in chronological order.

3/87: Portnoy guarantees all loans and debt of his company Mary Drawers (MD)

The trust document specifically states that Jersey law will govern the trust’s interpretation

During 1990 and 1992, P transferred his salary and real estate to his wife and daughter.

2/90: Lawsuit against MD for defaulted loan proceeds

9/91: Judgement against MD for ~$183,000

10/95: P files for bankruptcy. As part of his bankruptcy filings, he discloses the existence of the offshore Jersey trust. This is the first time his creditors have been informed of the trust’s existence.

Two points should be made before discussing the case’s legal reasoning.

First, Portnoy formed the trust after becoming aware that MD could not repay the loan. The court specifically noted this timing[2] because it was clearly a fraudulent transfer. Although the court did not connect this fact to specific badges of fraud contained in the Uniform Fraudulent Transfer Act, several are possible. For example, Portnoy concealed the transfer, only revealing it during bankruptcy proceedings 5 years after the trust’s formation.[3] In addition, as part of a unified series of transactions, Portnoy transferred most of his assets to the trust or family members,[4] essentially bankrupting himself in the process.[5]

Second, to attract asset protection business, some international offshore financial centers have amended their statutes to be more lenient towards debtors. Hoping to capitalize on the friendlier legal environment, planners add a clause to transactional documents stating offshore laws will govern the transaction. But these clauses aren’t the final choice of law arbiter; that rests with the court using the Restatement of the Conflict of Laws. In fact, several foreign asset protection trust cases – including Portnoy — ruled against the debtor due to the conflict of laws analysis.

The court ruled against Portnoy and his structure. The decision contains two important lines of reasoning; the first focused on the choice of law analysis, which required the court to determine whether Jersey or New York law would govern their interpretation. It began with the court noting that settlors are allowed to specify which laws govern their trusts and, that this should not be defeated “…unless this is required by the policy of a state which has such an interest in defeating his intention, as to the particular issue involved, that its local law should be applied.”[6]Later in the case, the court observes, “`[i]t is against [New York] public policy to permit the settlor-beneficiary to tie up her own property in such a way that she can still enjoy it but can prevent her creditors form [sic] reaching it.”

The importance of the preceding line of reasoning cannot be overstated: it strongly implies that planners attempts to invoke the laws of a debtor favorable jurisdiction will be defeated if the jurisdiction hearing the case has a public policy preventing a debtor from enjoying his assets at the expense of his creditors. Courts use this rationale in later asset protection trust cases, almost always to the debtor’s detriment.

The second important line of reasoning involved the court’s Conflict of Law’s factor analysis used to determine “the state whose interests are more deeply affected” – a factor in a Conflict of Law analysis. Here, the court noted that Portnoy settled the trust in Jersey, and had a Jersey firm administer the trust. But they then observed that all parties were U.S. residents. Additionally, the creditors had no contact with Jersey while Portnoy had extensive U.S contact when he established the trust. Due to the large number of U.S. contacts, the U.S. had the “weightier concern” about the litigation, thereby allowing the court to base its decision on U.S. law.

This part of the ruling shows the importance of “home court advantage.” Despite the assets being subject to a foreign jurisdiction, the parties are physically located in the U.S. Just as importantly, the creditors have no contact with trust’s jurisdiction. Here, the court ruled that the large number of U.S. contacts shifted the factual weight, meaning the court ruled for the U.S creditors. Finally, Portnoy’s jurisdictional contact pattern — an individual or group of U.S. based creditors sue a U.S. resident who has assets offshore – is very common in foreign asset protection trust cases.

Portnoy’s general reasoning laid a very strong groundwork for future court’s deciding FAPT trust cases. Future courts would decide against FAPT holders on several other grounds, but at the core of future reasoning is a general disdain for debtors who try to structure their affairs in a way to defrauds creditors. It’s simply not a practice that courts want to condone through their decisions.

[2] (“An inference can be drawn that the timing was purposeful, for in June, two months before the trust’s creation, Portnoy knew that Mary Drawers was in trouble and by December of that same year, Mary Drawers had defaulted on its obligations to Marine.”)

Author bio: Before law school, Mr. Hale Stewart was a bond broker with Vining Sparks, where his clients were comprised of mutual funds, insurance companies and money managers. He returned to law school in 2001, graduating from the South Texas School of Law in 2003. After law school, he opened his law practice focusing on transactional work. He continued his education at the Thomas Jefferson School of Law in 2007 where he obtained an LLM in domestic and international taxation, graduating Magna Cum Laude. He has three certifications from the American Academy of Financial Management: Chartered Trust and Estate Planner, Chartered Wealth Manager and Chartered Asset Manager. Mr. Stewart is also a member of the AAFM’s Board of Standards. He is the author of the book U.S. Captive Insurance Law and is currently working on his Ph.D. Mr. Stewart’s clients range the gamut from high net worth individuals who utilize one or all of his estate planning, asset protection or captive insurance skills, to small companies forming a captive, to larger associations looking for lower insurance costs. When not practicing law, he is usually writing on the economy at his blog, the Bonddad Blog.